Preface: “I think that the most important issue that will reshape our lives in the years ahead will be how man-made and artificial intelligence compete and work together.” — Ray Dalio
A Primer on Inflationary Business Conditions (Segment III)
From: Donald J. Sauder, CPA | CVA
When inflation accelerates in an economy impacting business conditions (the two go hand-in-glove), perhaps one contrarian point of prudent business cash flow management is that although a cash or cash equivalents absolute purchasing power may be eroding more rapidly, ample cash and cash equivalent holdings continue to remain vital to any business with a successful long-run plan to navigate thee inflationary period.
Why should a business hold ample cash and cash equivalents during inflation? Historically, when prices increase due to new money printing inflationary conditions, transferring operational costs uniformly to customers often has an evident lag time as both entrepreneurs and customers shift to become more accustomed to the new pricing patterns from the newly emerging trend of inflationary effects.
During this cash flow lag time between balancing increasing operating costs and increasing operating revenues, often financial margin pressures can crimp both a business’s cash flows and profitability. This can create increased cash flow stress for economic governance. Corresponding with the cash flow lag is that maintaining key business performance indicators such as accounts payable days or inventory days to within moderate or accepted vendor parameters is increasingly impractical for the unwary.
Therefore, companies who enter the race with inflationary periods with higher accounts payable days are early indicators of these rising cash flow pressures. This is because they may not have adequate cash reserves to pay timely, i.e., the financial indicator since they have already drawn more of the aggregate available excess credit, say from 25 or 40 days for permitted vendor payment(s).
On the contrary, as inflationary conditions initially erode profit margins and net business profitability, a business that, through keen and sharp management foresight, have built a strong balances sheet intentionally with either ample cash reserves, paid-off debt, or low accounts payable days will have a more extended runaway and more success manage the inflationary business lift.
Secondly, and more importantly, if inventory increases in cost, then retail, wholesale, or manufacturing balance sheets will need to expand along with accounts receivable? Understanding and managing working capital levels adeptly is therefore most necessary. For discussion purposes, if your inventory increases two or three hundred percent in cost, it will require twice or thrice the amount of cash (working capital) to hold that level of goods. This inflationary pressure leads to necessary astute management of working capital levels requiring greater access to revolving lines, etc., all perhaps during a critical time of increased financial risks. Any entrepreneur working on just-in-time working capital levels will be like a cruise ship in the ocean and lacking consumable drinking water, i.e., working capital.
A divergent approach believes that inflationary conditions lead to cash being trash, e.g., losing value rapidly, while maybe very relevant for cash profuse prime-time investors. It is not entirely applicable for a prudent small business cash flow manager.
A prudent cash flow management strategy is an essential concept during times of inflation. If prices rise if inflation gains altitude vertically for a longer duration than traditional cash flow management strategies permit, a business will be increasingly subject to borrow on revolving lines or, say, an emergency line of credit.
Again, this is all when the traditional lending environment is likely shifting credit strategies with perhaps corresponding higher interest rates: these factors compound management cash flow stressors and economic convergence with margins and profits. While predicting the duration and acuteness of these cash flow lag times is best deferred to top experts, If a business doesn’t plan appropriately nor have deep enough pockets or revolving credit facilities, it will lead to financial stress, crisis, or more adverse conditions.
While some cash flow managers may say that inventory builds are the better choice for excess cash, it does have merit that some businesses lack ample working capital to manage annual cash flow reserves without a material line of credit draw. With the unpredictable features of inflationary business conditions, keep foremost in mind that the classic adverse financial constraints are when a line of credit is at the limit, and additional cash is required. Like Rapid City, South Dakota weather, and other towns in the Great Plains, only the insiders understand the true implications and value of being appropriately prepared when inflation accelerates.
Therefore, a successfully inflationary business preparedness plan is likely unique based on industries, locations, and other financial, geographic, and demographic variables. If you appropriately manage cash or cash equivalents, you will have the economical fuel you need to successfully navigate and deliver on your business route.
To be continued….